The discussion around responsible investment reached a crescendo this year in the lead up to the much-feted Cop26.
Just ahead of this event, three governmental departments – HM Treasury, the Department for Work and Pensions and the Department for Business, Energy and Industrial Strategy – published their vision for the way the UK's finance industry can play its part in a brighter future for the planet.
The report Greening Finance: A Roadmap to Sustainable Investing is likely to have a fundamental impact on the way capital is deployed in markets through its insistence that "climate and environmental considerations should be central to the decision-making process of every UK board and every investor’s risk and return calculations".
This aspiration, as set out by the chancellor of the exchequer in his introduction, reflects a broader ambition within the global community to tackle the greatest environmental challenges society has ever faced. However, those working within the financial services industry could be forgiven for wondering what this means for them in practice.
The greater clarity that the roadmap provides on the direction of future regulation is to be welcomed. The indicative timelines on the publication dates of subsequent consultation papers acting as pre-cursors to regulation are also significant. While they might be ambitious, they will nonetheless help the industry plan for change.
Much has been said on the subject over recent years, and this report is confirmation of a renewed momentum behind responsible and environmental, social and governance investing, which should re-engage market participants and re-invigorate interest.
The roadmap identifies three phases, the first of which, "informing investors and consumers", is covered in this report and is directed at companies and asset managers, with an update due in 2022 following further consultation. The subsequent two phases will explore "acting on the information" and "shifting financial flows" in line with the government's net-zero commitments.
A key theme of this first phase is the flow of sustainability information from businesses to financial market participants. The aim is to provide the evidence that investors and businesses need to properly understand the full range of environmental risks they face and create; to tackle greenwashing by defining what is meant by sustainable; and to ensure that investors have access to reliable, high quality and intentionally comparable, and material ESG data.
The three main elements outlined in this document are: Sustainability Disclosure Requirements; UK green taxonomy; and stewardship.
SDR
Asset managers will be required to make investment product disclosures forming the basis of a sustainability investment labelling regime to identify the sustainability characteristics of the funds they manage. This will include metrics and targets, strategy details and risk management plans.
In addition, asset managers will need to disclose their net-zero transition plans, which must align with the government’s net-zero commitments. As part of the SDR, the Financial Conduct Authority will also introduce sustainable investment labels that allow consumers to compare the impacts and sustainability of their investments.
UK green taxonomy
The taxonomy will require funds to state the extent of fund investments in ‘green’ activities. These include pollution prevention and control; protection and restoration of biodiversity and ecosystems; sustainable use and protection of water; circular economy; climate change mitigation; and climate change adaptation.
In addition, activities will not count as green unless they also qualify as doing "no significant harm". It is important to note that all funds will be required to report on their exposure to green activities regardless of whether they are labelled as sustainable or not.
Stewardship
Stewardship is defined as the “responsible allocation, management and oversight of capital to create long-term values for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society” (Financial Reporting Council, UK Stewardship Code 2020).
Most asset managers already engage in activities commensurate with their responsibilities as stewards of capital. This roadmap, however, outlines ongoing expectations and additional requirements, such as increased transparency and a greater emphasis on the transition to net zero.
Although the roadmap states that HM Treasury and the FCA are exploring how sustainability-related requirements for financial advisers can be introduced, and how sustainability is considered in the investment advice and suitability process, this is subject to further consideration. Therefore, the immediate direct impact on advisers and fund buyers is limited. But the roadmap gives a clear indication of legislative intent bringing major implications for advisers.
It is clear that the ability to understand and explain the new reporting to clients, and to incorporate it into their decision-making will be of critical importance for advisers. According to the roadmap, 70 per cent of the public want their money to go towards making a positive difference to people or the planet. Investors will look to their advisers for guidance on these sorts of investments and so being able to provide positive, informed advice will be crucial in the years ahead. Furthermore, when the sustainability investment labelling regime is imposed, advisers will need to be able to understand the function of different types of sustainable investments and how they relate to the needs of investors.
The coming months will see a raft of consultation papers on the regulation and requirements outlined in the roadmap. For now at least, advisers and fund buyers have time to reflect on how to ready themselves for upcoming legislation, based on the initial guidance this report offers.
Steve Kenny is chief distribution officer at Square Mile Investment Consulting and Research
